Sunday, September 29, 2013

The "Gridlock" of the Many Owners of the Securitized Mortgage

Miami Personal Bankruptcy Lawyer Jordan E. Bublick has over 25 years of experience in filing Chapter 13 and Chapter 7 bankruptcy cases. His office is centrally located in Miami at 1221 Brickell Avenue, 9th Fl., Miami and may be reached at (305) 891-4055.

It is well know to commercial attorneys that business or "commercial" trusts came to dominate many types of modern financial transactions. Trusts are widely used in the structuring of pensions, mutual funds and asset securitization trusts. See, Steven L. Schwarcz, Commercial Trusts as Business Organizations: Unraveling the Mystery, 58 BUS. LAW. 559 (2003), Steven L. Schwarcz, Alchemy of Asset Securitization, 1 STAN.J.L.BUS. & FIN. 133 (1994), John H. Langbein, The Secret Life of the Trust: The Trust as an Instrument of Commerce, 107 YALE L.J. 165 (1977). Now, due to the crisis with mortgages and the needs for mortgage modifications, even the average American citizen is aware of the commercial usage of the trust for the securitization of mortgages as well as the "gricklock" created thereby.

The "commercial" use of a trust is in contrast to the traditional "gratuitous trust" that a family member may set up as part of his estate planning. In a traditional gratuitous trust, the donor of the gift is the "settlor" of the trust and transfers assets to the trust to be managed by the trustee for the benefit of the beneficiaries. In contrast, with a commercial trust, such as an mortgage securitization trust, a settlor transfers financial assets in return for payment for the financial assets. With mortgage securitized trusts, mortgages are originated and then quickly assigned by the originators and brokers into large pools held by trusts. Christopher L. Peterson, Predatory Structured Finance, 28 CARDOZO L. REV. 5 (2007), Adam B. Ashcraft, Til Schuermann, Understanding the Securitization of Subprime Mortgage Credit, Federal Reserve Bank of New York Staff Report no. 318 (2008).

Trust certificates are then sold to investors to raise funds from the capital markets. "A trust certificate is simply a writing that evidences the holder's undivided interest, to the extent specified in the writing, in the trust assets." Schwarcz, Commercial Trusts, supra note 25. This is in accordance with basic trust law that the creation of a trust divides title to the trust property, placing legal title in the trustee and equitable title in the beneficiary. A beneficiary's interest in the trust property constitutes a vested interest in the property itself. 76 Am Jur., Trusts, Section 258, 259.

Certificates in securitized mortgage trusts are issued in various tranches with various ratings by the three national rating agencies, Standard and Poor's, Moody's, and Fitch Investment Company. One certificate may entitle an investor to receive all the interest income (an "interest-only tranche") while another may entitle an investor to receive all payments from loan principle (a "principle-only tranche"). The credit worthiness of some tranches is augmented by "credit enhancements", such as letters of credit, guaranties, insurances, and swaps.

Pursuant to a "pooling and servicing agreement", the mortgage held by the trust are serviced by one or more servicers, such as a master servicer, default servicer, and special servicer. Due to their limited authority, servicers have been unable to meet the needs of homeowners for "loss mitigation" or mortgage modification. Servicers are fearful of being sued by the trusts or certificate holder if they modify the mortgage. In fact, in a recent case, certificate holders have filed suit against Countrywide and Bank of America for agreeing to modify mortgage in their settlements with the various state's Attorney Generals. Underlying the servicers' lack of authority is the inherent structure of the trusts where interests of varying natures in the mortgage have been sold to the certificate holders which produces an inherent conflict of interest whereby a mortgage modification may be beneficial to one group of certificate holders but harmful to another. The result is gridlock.

Professor David Dana of Northwestern University School of Law recently explored in his article The Feudal Mistake the "excessive fragmentation" of ownership interests in securitized mortgages and the creation of a situation whereby it is nearly impossible to re-work a mortgage. This theme of excessive fragmentation of property interests, whether in land, intellectual property, or finance, is the subject of this year's "must read" (Business Week, December 25, 2008, page 82) The Gridlock Economy: How Too Much Ownership Wrecks Markets, Stops Innovation, and Costs Lives by Columbia University law Professor Michael Heller. In this work, Professor Heller explores the "free market paradox: usually, private ownership creates wealth, but too much ownership has the opposite effect – it creates gridlock. When too many people own pieces of one thing, cooperation breaks down, wealth disappears and everybody loses."

Which bring us to the today's American mortgage crisis and Chapter 13 of the Bankruptcy Code and its capability of cutting this Gordian knot of "gridlocked" securitized residential mortgages. Particularly, section 1322(b)(2) of the Bankruptcy Code provides that claims, such as mortgages, are not modifiable if they are secured only by an interest in real property that is the debtor's principal residence.

The first question presented is who is the claimant, ie. who owns the mortgage held by the securitized trust. Although legal title to the securitized mortgage is held by the trust's trusee, it would appear that the beneficial ownership of the securitized mortgages has been fragmented and diffused. Per basic trust law, although the securitized trust holds the legal title to the mortgage, the certificate holders hold the equitable title. In fact, with securitized trusts, the equitable title may be split among the hundreds or thousands of certificate holders who have competing interests per the various tranches in the mortgage. Hence the gridlock in modifying the securitized mortgages and the optimization of this "resource."

Perhaps deserving closer examination is the issue whether the claim in the mortgage as beneficially held by the hundreds or thousands of the certificate holders is secured only by an interest in real property? If not, apparently the mortgage would be modifiable under Chapter 13 of the Bankruptcy Code.Perhaps there have been "add-ons", such as the various credit enhancements, as the mortgage was passed along to the trust and certificate holders.